Pulse: Top Internet Stocks Dogged by Skittish Investors

They used to be treated like the best of breed stocks in the Internet sector. But today,

Yahoo!

(YHOO)

,

America Online

(AOL)

and

eBay

(EBAY) - Get Report

looked a little more like ordinary mutts in today's trading.

All three dropped in trading this morning on a combination of individual factors and investor skittishness over anything to do with Internet advertising and e-commerce. They took

TheStreet.com Internet Sector Index

with them. The DOT was down 5.6%.

Yahoo! led the way down, closing off $7.19, or 14.7%, to $41.69, following a morning downgrade from

Morgan Stanley Dean Witter

analyst

Mary Meeker. eBay, which dropped 20.6% Monday after being downgraded, dropped another $2.94, or 8.5%, to $31.56 -- even after an upgrade from

C.E. Unterberg Towbin

. And mighty AOL, usually considered the sector's safest bet, was down $4.09, or 8.7%, to $43.

Meeker's note faulted the giant portal for failing to find profits in its popular features, relying instead for 90% of its revenue on the "tough and wacky" Internet advertising market. She predicted that Yahoo! had a 30% chance of missing its revenue targets for the quarter. Yahoo!, Meeker wrote, "does the worst job, so far, and by far, of monetizing its customers, compared with other leaders

AOL, eBay and

Amazon

(AMZN) - Get Report

." Meeker also questioned whether Yahoo! was spending enough money to keep its brand in front of consumers and whether it was succumbing to the "Apple syndrome" of introspection and parochial focus.

Influential

Merrill Lynch

analyst

Henry Blodget wrote in a sector update that Internet companies haven't seen the worst of the advertising crunch yet -- that it will come in the first quarter of the coming year. And Yahoo!, Blodget wrote, is "facing the toughest challenge of

its young life: the first 'harsh winter'."

This continuing advertising downturn also hurt giant AOL's stock today, but so may other factors dealing with its impending merger with

Time Warner

(TWX)

. Investors are still nervous about the delay on a

Federal Trade Commission

ruling over their merger.

They also may be worried that Time Warner gave too much in the deal it made with

Earthlink

(ELNK)

yesterday, opening up access for high-speed Internet service across its cable lines, said analyst Ken Kiarash of

Buckingham Research

. (The firm has no underwriting relationships with AOL or Time Warner.) AOL and Time Warner may have rushed the agreement because they needed it to show the FTC they were open to competition.

"They needed this deal to close; they couldn't afford to let it slip," Kiarash said. "They've put the national ISPs in the catbird seat. The deal they signed with Earthlink is on terms much more favorable to ISPs and much less favorable to Time Warner. This deal will be the blueprint for the others."

eBay may be facing its own set of problems. Yesterday shares of the online auction company fell more than 20% after a downgrade from

Lehman Brothers

, which panned the company's projected annual compounded growth of 50%. Today, C.E. Unterberg Towbin analyst Dan Ries upgraded the stock from buy to strong buy. Ries' points: The price drop (eBay has lost 71.7% since its March high.) has left an attractively valued stock, given its growth, which looks very good for the fourth quarter.

The stock fell again anyway.

"Nobody has a lot of confidence in this sector," said Fred Dickson, manager of equity research at

Branch Cabell

. (The firm does not do investment banking.) "They

eBay need a continuation of a strong economy to hit their numbers. With signs that growth is slowing down, how much are people willing to support the stock from valuation contractions?"

Dickson said he has also noticed a pickup in tax-loss selling among the firm's retail clients. (Investors have until the end of the year to reduce their tax bills by dumping losing stocks.)

2:23 p.m.: Semis Struggle Following Avnet Warning

The snowball that started with an announcement by

Cisco

(CSCO) - Get Report

about

excess chip inventory got another push downhill -- taking up a few semiconductor stocks with it.

The Philadelphia Stock Exchange Semiconductor Index

was trading down 4.4% after large semi distributor

Avnet

(AVT) - Get Report

announced Monday it would fall short of earnings estimates for the coming quarter. This announcement came as no huge surprise, given the many recent earnings warnings this season. But what provoked interest was Avnet's comment that its miss was based on an inventory correction in the industry and that the correction was broadly based across the different types of semiconductors that the company distributes. In a note today,

Merrill Lynch

revised its earnings estimate on Avnet, which was trading down this morning $3.88 or 17% to $18.81.

Avnet's news took down

Xilinx

(XLNX) - Get Report

-- whose programmable logic devices are distributed by Avnet -- by $6.25, or 10.2%, to $54.81. Competing PLD makers

Altera

(ALTR) - Get Report

and

Lattice Semiconductor

(LSSC)

also dropped on the Avnet news. Altera was trading down $2, or 6.6%, to $28.13 and Lattice was off $1.06, or 5%, to $19.81

The news added to the woes of

LSI Logic

(LSI) - Get Report

, off $6.19, or 21.5% to $22.56 after it announced that CFO Douglas Norby and John Daane, head of its communications chip group, would be leaving.

Avnet's comments over the past day have focused attention on the ongoing debate over whether the chip sector is headed for the soft landing of an inventory correction or a harder fall of a cyclic downturn. At an analyst meeting today, Avnet executives said they thought the inventory correction would be over by the end of January.

Some analysts see a reduced cycle, with manufacturers (their worries about supply eased) placing smaller orders with semi makers and pushing margins down.

Other analysts see the correction as being little more than a hiccough in the market.

"We're seeing a pause in demand, we're not expecting a contraction in demand, " said

SG Cowen

analyst Jack Romaine, who has Altera and Xilinx pegged for 40% growth in the coming year. (SG Cowen has done no recent underwriting for Altera, Xilinx or Lattice).